Illustration: Vincent Mahé

Indigo, Concealed Value in Retail?

Retail stocks recent sell-off discounted brick-and-mortar assets almost indiscriminately. It is expected of disruptors — online low cost competitors — to keep on hurting incumbents’ businesses. Yet, I contend best-in-line operators can get through the turbulence unscathed, perhaps thrive given a new set of opportunities. It follows that some productive retail assets likely sell at a fraction of fair value given current pessimism.

Indigo’s equity ($IDG, TSX) appeared on my radar recently for trading at a 6.1x EV/EBIT multiple, an ostensibly depressed valuation.

Indigo is Canada’s largest brick-and-mortar book, gift and specialty toy retailer. It operates 80 large format stores under the banners Chapters and Indigo, and 123 small format stores under the banners Coles, Indigospirit, Smithbooks and The Book Company.

The retailer sports a cash rich, outwardly conservative balance sheet with $230.4 million (CAD) in cash, cash equivalents and short-term investments and has no debt outstanding. The equity trades for $408.4 million,EV $178 million.

For fiscal 2017, sales breached record $1 billion making for a $29 million operating profit, a slim 2.5% margin. 2016 operating result was $22.1 million, preceded by losses in 2015 and 2014 of -$3.2 and -$26.9 million respectively, and a break-even 2013. While Indigo didn’t turn an operating profit over the past 5-year period as a whole, both revenue and operating margins trended upwards.

From a cash flow perspective, operations proved positive with a $29 million average inflow per year over the same period. 1/2 has been reinvested in the business in initiatives such as store renovation, concept innovations and online platform enhancements.

The $408.4 million price tag simply extrapolates recent performance with slight margin improvements going forward. I would argue that current depressed valuation and cash rich balance sheet offer an attractive asymmetric bet on Indigo’s future. Probable foreseeable scenarios include improving fundamentals, retail industry performance reversal, i.e. multiple expansion, or even profitable liquidity event (e.g. liquidation, merger).

Disclaimer: this is not meant as financial advise.

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